“The Panic Button’s Been Hit Again” – Dubai World Defaults on Debt

27 November 2009. Is this the trigger for the next round of the financial crisis?[br]

27 November 2009. Is this the trigger for the next round of the financial crisis?[br]

27 November 2009. Is this the trigger for the next round of the financial crisis?[br]

27 November 2009. Is this the trigger for the next round of the financial crisis?[br]

Dubai has just announced that it will ask for a six months ‘standstill’ in debt repayments for stated-owned holding company Dubai World, “as a first step towards restructuring”. Dubai World has $59 billion in outstanding debt, a large portion of the estimated $80 billion – $100 billion of debt that Dubai carries (148% – 200% of 2007 GDP), off the back of a real estate boom and building binge that the Middle East Capital of Bling carried out over the last decade.

This included the building of the recently opened Burj Dubai, the tallest tower in the world, and three man-made palm-shaped islands off the emirate’s coast. The latter was constructed by Nakheel which is owned by Dubai World, and which is at the center of the storm.

Nakheel has $3.52 billion in bonds that were due to be paid up on the 14 Dec 2009. That repayment will be put on hold, as will interest on all other debts. The leaders of Dubai World, Nakheel and other subsidiaries were sacked and replaced a week ago.

The Emirate is trying to shore up confidence by moving to signal support for profitable ports operator DP World. Although DP World is majority owend by Dubai World, it is also listed on NASDAQ. It has $3.25 billion in outstanding bonds, but Dubai World said DP World would not be involved in the restructuring.

RGE Monitor, the economics group started by Professor ‘Dr.Doom’ Roubini, says that the market views this technically as a default.

[quote]So far in 2009, all the maturing government-linked debt of Dubai has been paid off in full, with government funds making up any shortfall in private funds.  Yet, given the vulnerabilities of the property sector and challenges of the economic model, Nakheel could be a different story given the government’s desire to support only viable companies. Yet, the costs in raising future funds may thus be even more costly. The lack of transparency about corporate and national finances and which debt might be honored, is adding to uncertainty and credit risk.[/quote]

It is seems that the Dubai Sheikhs are moving to pick and choose which government entities they support – indeed, with property prices having fallen a staggering 50% since their peak, they may have no choice. That means that Nakheel’s debts may not be honoured.

The Financial Times Lex column said

[quote]The consequences of the standstill, and possible eventual default, are far-ranging. The repayment of Dubai World’s US$4 billion Nakheel bond was seen as a litmus test for the emirate’s ability to deal with the US$80 billion owed by the sovereign and its state-controlled companies. The emirate’s willingness to do this is now in doubt, especially as only an hour earlier it raised $5bn from two state-controlled banks in Abu Dhabi. This was only half what had been expected, but followed $10bn of earlier support from the kingdom’s richer neighbor. Foreign creditors are muttering darkly about taking legal action. [/quote]

There are so many – to borrow a Lex word – darkly fascinating aspects to this story.[br]

Creditors may mutter darkly about taking legal action, but in the UAE the word of the Sheikh’s is the law, so if they say it will be re-structured then it will be.

The fact that $5 billion was raised from banks in Abu Dhabi moments before the announcement is instructive on many levels. Abu Dhabi, the vastly richer and less flashy brother Emirate, will provide support to Dubai, as will Saudi Arabia and other Gulf GCC states. However they too will limit their exposure. This $5bn was only half of the $10bn that was expected. The message might have been ‘we will support the healthy core, but you must trim the toxic excess’.

Other Emirates and GCC members have become increasingly jealous of the attention that Dubai has garnered, but their economic health are intertwined. This support probably comes with strings, and is a may to cut Dubai back down to size while attempting to stop the spread of contagion.

The relative calm in the financial marketplaces during the last six months has been entirely dependent on the support of governments, who have been shoring up, bailing out and guaranteeing left right and center. Some governments are simply unable to continue doing that, as their own – sovereign – finances are being stretched to the limit. And some support will need to be wound down to reduce the size and riskiness of sovereign debts that have ballooned across the world.

That calm has been shattered, leading Francis Lun of Fulbright Securities to say “the panic button’s been hit again”.

Because of Thanksgiving in the US and Eid in Asia and the Middle East, many markets have been closed. However open markets and futures have been taking a battering. Not surprisingly, financial firms and construction compananies have borne the brunt of the bloodshed.

HSBC and Standard Chartered banks, both exposed to Dubai World, are down 5% and 10% respectively on Thursday, as European stocks took their biggest dives since the March rebound, dropping 3% overall.

Dubai’s sovereign debt ratings, predictably enough, have been cut, with many state-owned companies now at junk bond levels. Overall, this means that borrowing costs will be about 50% higher. The cost of Credit Default Swaps (CDSs) for Dubai, insurance against a default, jumped 228 basis points. That means that Dubai is now considered more risky than Iceland, the basketcase of 2008.

CDS prices – and therefore the perceived risk of default – also jumped for Bahrain, Qatar, Turkey, Russia, Greece and Ireland. Lars Christensen of Danske explained that

[quote]The contagion spreading from Dubai to the CEE, Turkey and South Africa is more natural than one might think. The worries concerning Dubai focus on potential banking losses and given the fact that the banks with the largest exposure to Dubai are also big players in, for example, South Africa, it is only natural that the rand has come under pressure. [/quote]

Big banks and emerging market currencies are all taking a hit, while the US dollar is rebounding. 

Goldman Sachs analysts believe that HSBC could lose $611 million and Stan Chart could be short $177m, Sumitomo Mitsui could lose $225m and Mizuho may be down $100m. DBS Bank in Singapore is also thought to be exposed. When it comes to money, Goldman Sachs are normally all over it, so this is probably a pretty good guess. A lot of banks already have very shaky finances, and they will be hit next year by increasing losses in areas such as commercial real estate and credit card debt. With borrowing costs increasing again, more sovereign debts may be deferred or cancelled.

Can the banks, many of which are only surviving thanks to government largesse, make it through? RGE Monitor’s Arnab Das says

[quote]The Dubai situation signifies that although the major central banks around the world have stabilized the financial system, they can’t make all the excesses simply disappear.[/quote]

I was watching Channel News Asia a few days ago, and they used a phrase that stuck in my mind: the markets are looking for direction.

I think they just found it.

Keith Timimi

EconomyWatch.com